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Pre-Sale Market 2018 PDF
Pre-Sale Market 2018 PDF
Pre-Sale Transactions
Kwok-Sang (Maurice) Tse
k s tse 1
Reference
“Do the Forward Sales of Real Estate Stabilize
Spot Prices?”, Journal of Real Estate Finance
and Economics, 2006
Introduction
Before the crash of the real estate market in 1998 in Hong
Kong, the pre-sale market had always been blamed for the sky
high property price level which was beyond reach by many who
wanted to become property owners.
To the investors in the real estate market, pre-sale transaction
was a quick way to generate quick returns and profits.
Example
Consider a residential property on Hong Kong Island called, Illumination
Terrace, Tai Hang Rd 5-7, Jardine’s Lookout (Appendix).
HP Day
Floor Unit Price G. Area T. Date OP Date # days return Return
1 E 2.755 758 5-May-93 93/07
Example Contd: 1
1
E
F
3.25
2.492
758
696
22-Jun-93
29-May-92
93/07
93/07
48 16.52% 0.34%
Pre-Sale 2
2
F
G
2.591
2.501
696
696
2-Jul-92
8-May-92
93/07
93/07
31 5.39% 0.17%
Transactions in 2
2
G
G
2.53
3.152
696
696
20-May-92
19-Apr-93
93/07
93/07
12
334
1.15%
21.98%
0.10%
0.07%
2 G 2.68 696 30-Apr-93 93/07 11 -16.22% -1.47%
Lower Units 2 H 2.599 769 5-May-92 93/07
2 H 2.77 769 28-May-92 93/07 23 6.37% 0.28%
between May 92 2 H 2.73 769 4-Aug-93 93/07 433 -1.45% 0.00%
3 C 3.871 979 4-May-92 93/07
to July 93 3
3
C
D
4.1
3.301
979
903
5-May-93
8-Jul-92
93/07
93/07
366 5.75% 0.02%
Example Contd:
40 D 4.2 910 30-Apr-93 93/07 458 12.57% 0.03%
40 E 2.918 758 5-Mar-92 93/07
40 E 3.158 769 28-Apr-92 93/07 54 7.90% 0.15%
40 E 3.53 769 6-Feb-93 93/07 284 11.14% 0.04%
40 E 3.43 769 13-Apr-93 93/07 66 -2.87% -0.04%
40 E 3.968 769 19-Jun-93 93/07 67 14.57% 0.22%
40 H 2.995 769 4-Mar-92 93/07
40 H 3.28 769 25-Mar-93 93/07 386 9.09% 0.02%
41 F 2.656 696 28-Feb-92 93/07
41 F 3.18 696 5-Nov-93 93/07 616 18.01% 0.03%
ILLUMINATION 41 G 3.28 696 20-May-93 93/07
LOOKOUT (渣甸山) 42
42
E
F
3.502
2.671
769
696
21-May-93
13-Feb-92
93/07
93/07
387 9.87% 0.03%
Pre-Sale
42 F 3.05 696 15-Mar-93 93/07 396 13.27% 0.03%
42 G 2.74 696 7-Mar-92 93/07
42 G 2.879 696 17-Mar-92 93/07 10 4.95% 0.49%
Transactions in 42
42
G
G
3.268
3.16
696
696
3-Jan-93
4-Feb-93
93/07
93/07
292
32
12.67%
-3.36%
0.04%
-0.11%
Upper Units 42
42
G
H
3.15
2.769
696
769
14-May-93
2-Mar-92
93/07
93/07
99 -0.32% 0.00%
between May 92 42
43
H
A
3.83
4.98
769
910
31-May-93
5-Jul-93
93/07
93/07
455
35
32.44%
26.26%
0.07%
0.75%
to July 93
43 A 4.5 910 3-Dec-93 93/07 151 -10.14% -0.07%
43 C 2.958 696 4-May-92 93/07
43 C 4.48 989 4-Aug-93 93/07 457 41.51% 0.09%
43 E 2.933 769 6-Mar-92 93/07
43 E 3.173 769 30-Apr-92 93/07 55 7.87% 0.14%
43 E 3.58 769 6-Jan-93 93/07 251 12.07% 0.05%
43 E 3.28 769 15-Mar-93 93/07 68 -8.75% -0.13%
43 G 3.215 696 26-Apr-93 93/07 42 -2.00% -0.05%
43 G 3.215 696 4-Aug-93 93/07 100 0.00% 0.00%
44-45 A 5.163 1230 17-Mar-92 93/07
44-45 A 6.3 1230 24-May-93 93/07 433 19.90% 0.05%
44-45 A 6.55 1230 6-Oct-93 93/07 135 3.89% 0.03%
Important Figures
The average holding period = 92 days
The average holding-period returns = 10.21%
The average daily return = 0.187%
The annualized average return = 28.48%
The return on Hang Seng Index between May 92 and July 93 = 16%
The units with the highest average daily return
HP Daily
Floor Unit Price G. Area T. Date OP Date # days return Return
22 B 5.35 989 93/07 1 6.77% 6.77%
42 C 5.545 989 93/07 3 16.11% 5.37%
2 D 3.521 903 93/07 3 7.49% 2.50%
7 D 3.334 910 93/07 4 7.08% 1.77%
8 F 3.73 696 93/07 26 36.48% 1.40%
23 A 3.83 910 93/07 37 33.13% 0.90%
43 A 4.98 910 93/07 35 26.26% 0.75%
Introduction Contd
In 1995, the Hong Kong Government said, “Pre-sale market is the
hotbed of speculative activities in the real estate market.”
Since then the Government had been using the pre-sale market
as a tool to control the speculative transactions in and hence the
price level of the property market.
For example, in 1995, the Government essentially prohibited pre-
sale market transactions.
We saw the plunge in the supply of residential real estate.
After the Asian financial crisis broke out, the property price in
Hong Kong fell by as much as 70 percent.
And the HKSAR Government began to relax the restrictions on
pre-sale transactions with the hope to revive the level of
transactions in the property market.
Jan 2002: $3,000 psf
Property Price July 2003: $2,200-2,400 psf
in Hong Kong April 2004: $3,500-$3,800 psf
Dec 2007: $5,500 psf
TKS = Tai Koo Shing ( 太 古 城), 28-30 years old residential estate on east side
of Hong Kong Island, popular choice of residence among expatriates.
Dec 2011: >$8,800
Residential Property Price
per 2014:
Dec sq. ft of gross area
> $18,000 TKS Asian
Jan-93
Jan-94
Jan-95
Jan-96
Jan-97
May-
May-
May-
May-
May-
May-
Sep-
Sep-
Sep-
Sep-
Sep-
Sep-
Month/Year
k s tse 8
Introduction
Function of Pre-sale Market to Real Estate Developer
Questions:
What’s the use of the pre-sale market to the
developer??
What’s the effect of pre-sale transaction on the real
estate supply??
From what happens in the pre-sale market, what can
we say about developers’ view on the future real
estate prices??
Supply Decision of Real Estate Developer
Supply quantity ??
Pre-sale quantity ??
Supply quantity (q)?
Sell the rest of the units (q-h).
How many units (h) to pre-sell?
Price is unknown at t = 0
Pre-sale Price known (pf)
estate market, how would the profit risk affect the supply
decision of the developers??
Analysis: Effect of Risk-Aversion
Developer is risk averse.
Since they are risk averse, they are conservative when
making development decisions based on the projected
profit.
Developer will not choose q and h just to maximize
expected profit.
Developer will maximize the certainty-equivalent profit.
What is certainty-equivalent?? Concept??
Concept of Certainty Equivalent
Certainty Equivalent is the amount of money the developer is
willing to take in order to avoid taking the profit risk.
$5m $4.5m
Concept of Certainty Equivalent
How much insurance the property owner wants to buy depends
on his/her degree of risk aversion.
The more risk aversion, more insurance will be purchased, hence
the smaller the certainty equivalent.
The amount of insurance purchased also depends on the
probability of fire risk (or the variance of his/her net wealth after
fire risk)
$3.2m $5m- 0.5m =4.5m
Fire Fire
No Insurance Insurance
No fire
No fire
$4.5m
$5m
Certainty Equivalent of Profit
The amount of profit the developer is willing to give up to
avoid risk can be described by the following picture
Variance
Var(~)
2
Mean Profit
CE
p cq (q h)s p2 0
q
CE
p f r p f p (q h)s p2 0
h
The solution for optimal supply of units of property (q*) is
found by adding the two equations together:
p f (1+ a ´ r)
p f + a r p f - cq = 0 Þ q = *
c
Implications of Pre-Sale Market
Supply of space depends only on
pre-sale price
p f (1 r )
variable cost
q *
c
use of pre-sale revenue
CE p
p cq (q h)s p2 0 q
'
q c s 2
p
Optimal supply decision The higher the price risk (sp2 ), the
depends on: lower the supply quantity (q’ ).
Expected future spot price
Price
p q’
q' q*
c s 2
p
p f (1 r )
q
*
c
0 Supply Quantity
Statement about Pre-Sale Transaction
s p2
Implications:
If p < pf (1 + r), total output of space q* will be pre-sold.
A risk averse developer will exchange an uncertain price
for a certain one if the latter equals the expected value
of the uncertain one.
However, the expected and the actual future spot price
may not be equal.
p p f (1 r )
Implications Contd h q
* *
s p2
Risk averse developers will exchange a certain price pf for the
uncertain spot price only if the expected spot price includes a risk
premium. That is,
p > pf (1 + a r)
Consider the case when p > pf (1 + a r)
Now q* must exceed h* and the firm will hedge some of its space
output.
The developer sells part of the output at the forward price pf and
sells the rest upon completion for the uncertain spot price.
The more risk-averse the developer, the greater the level of
hedging for the same positive price difference between p and pf .
p p f (1 r )
Implications Contd h q
* *
s p2
Questions: What can we say about the effect of the
following factors on the pre-sale quantity??